412i Coverage/Nondicrimination Test

[Guest merlin]

If a 412i plan defines the accrued benefit as the CSV of the contracts, and the CSV = 0 at the end of the plan's 1st year, does that mean that the plan automatically passes 410b because no HCE benefits? The answer would seem to be "yes" but it doesn't pass the smell test.

Whatever the answer, the same reasoning would apply to the a4 test if the plan is not a safe harbor (which it won't be if it's funded with insurance and annuities, at least according to Jim Holland), right?

[Guest Carol the Writer]

I don't want to play the devil's advocate, but is this where fair market value comes in? The CSV may be zero, but, again according to Jim Holland, the FMV would not be zero. Two more things. What is fact is the FMV here? And I am NOT suggesting that Jim Holland is the devil!

[Belgarath]

Merlin - I'm just speculating here, but does the accrued benefit perhaps have a definition that says something to the effect that the accrued benefit is the cash value of the contracts, assuming all required premium payments have been made? That would make more sense to me, and is in line with 412(i) docs that I have seen - and it would be impossible to end up with a zero value on an annuity policy in that circumstance. (And I'm not going to discuss a plan that has only life insurance, 'cause that would be verboten anyway) If the document doesn't say something to that effect, somewhere in the document, then I would say it is a faulty document.

[AndyH]

Merlin, the sales person benefitted. The CSV went to him. Sorry, I could not resist.

[Guest merlin]

Carol,

I don't think FMV comes into play here. That's a taxation issue. Mike Spaid mentioned this in his 412i session at ASPPA last October.

Belgarath,

The plan doc (Corbel) defines the accrued benefit as "...the cash surrender value of any Contracts in force used to fund a Participant's retirement benefit. With regard to such Contracts:

(a) they shall provide for level annual premium payments to be paid for the period commencing with the date that each individual becam a Participant in the Plan (or,in the case of an increase in benefits, commencing at the time such increase becomes effective and extending to the Normanl Retirement Age of each such individual;...". Is this the language you're referring to? What does that tell me?

Also, Mike Spaid alluded to funding a 412i exclusively with insurance in his outline. If the insurance amount meets the incidental rules, where is the issue? Or is the incidental test restricted to 100x, because 74-307 will generate a csv at NRD greater than what is needed to fund the retirement benefit?

Andy,

No need to apologize. I'm always happy to be your straight man.

[Belgarath]

Merlin - well, if it isn't spelled out a bit more clearly somewhere else, then I think you are left with interpreting the document to say what is necessary.

"(a) they shall provide for level annual premium payments to be paid for the period commencing with the date that each individual becam a Participant in the Plan..."

I'd interpret this to require a premium payment. Suppose it is a 12-31-03 end of year plan. Depending upon plan language and practice, etc., I'd assume this requires a level anual premium, commencing sometime within 2003 - perhaps 12-31-03. Even if the contribution hasn't been made yet, it is REQUIRED to be made, and the benefit is based upon that, I believe. In other words, if the participant terminates employment on 1-3-04, he can't receive a zero benefit just because the employer hasn't sent in the check yet. So I think for testing purposes, you have to assume a benefit on 12-31. The 412(i) docs I've seen spell this out rather more clearly.

As far as the incidental limits, I'm not familiar with the outline you refer to. But in order to be "incidental" it isn't possible to have 100% of the benefit funded by life insurance. So there will be some annuity premium. The 100% to life insurance doesn't fly, (most of us NEVER thought it did) and the IRS made this clear in February. If you have a plan funded 100% with life insurance, I'd run like heck!

[Guest merlin]

Belgarath,

At this point the question is semi-academic. I've been asked to do a 412i proposal for an agent, which I really can't do because I don't know what carrier he's going to use and I don't have the appropriate rates anyway. But I would like to be able to point out any potential trouble spots with 410b and/or a4 before anything gets sold. And if annuities have to be in the mix don't I have an a4 issue, because insurance and annuities are inherently different, and therefore don't meet the "same policy series" rule, thereby blowing the safe harbor?

Is RR 81-162 the basis for your statement that an insurance-only 412i plan is n.g.?

[Guest flogger]

One of the issues Mike Spaid had brought up was the TH min accruals. Since the definition of AB is derived from the CSV of the ins/annuities, the PVAB of the TH min had to be less than or equal to the CSV (my interpretation). If this is not the case, then additional side funding would be required and then the 412(i) requirements would not be met (i.e., there would be assets other than the insurance and annuities).

This is relevant because of the original question in this thread. If the contribution had not been made as of 12/31, then are the assets as of 12/31 a receivable equal to the premium? Would that not cover the accrual requirement and meet the significant benefit requirement? I don't agree, just a thought--and there could easily be 411d6 problems with the value of the AB in the following year.

Rev Proc 2004-16 states the CV must be at least as great as the aggregate of Premiums paid plus earning less reasonable charge (such as mortality). However, I believe this only applies to the determination of a distribution amount and not the accrued benefit. Does anyone agree/disagree?

[Guest merlin]

In the real, i.e., non-insured, world it makes sense to count the rec'ble at full value because that's how it will be invested. But with insurance most of the premium,i.e, the investment, goes into the dumper. It seems to me that the only thing you can do is look at the contract to see what the net csv is after payment of the premium and use that number as your PVAB. On that basis, if the PVABs for the Keys is >60% of the total your plan is t/h, and if any of the individual PVABs converts to an accrual of <2% of comp you have to make the add'l contribution to fund the t/h minimum. All of this assumes that your 412i plan document doesn't define the AB in a more traditional manner.

And the FMV issue only arises in terms of the taxation of the distribution. I'm pretty sure Mike Spaid said that in his presentation. It's not in the outline.

[Guest flogger]

Unfortunately, non-insurance people have to deal with the insurance people all the time. If you are against abortions, you still have to deal the reality of them occuring. In that vein, I have suggested to an insurance man who insists on making huge unsubstantiated commissions on 412i's that he and his clients could be better served by:

Funding a traditional DB Plan in the same way that a 412i could be funded. Since all the assets would be funded on a guaranteed basis with insurance and annuities, the guaranteed rates might be reasonable actuarial assumptions for funding purposes. Of course, as crediting rates exceed the guaranteed rates, there would be gain/losses and adjustments made thereto. This would also require the intent to annuitize the benefit with the contracts that are being used to fund the plan. Also, the "same series" concerns become moot.

The traditional definitions of AB and all the TH requirements would be used and not the 412i definitions. An actuary would be needed, but one is anyway if they are going to run the plan properly--so what if a Sch B is needed. However, if a termination occurs, the employer would have to dump some cash into a side fund to pay off the PVAB--and the underlying funding method would determine the deductibility of such.

As an actuary, I have a problem with rates as low as a 2% pre and post interest rate assumption, and I would want to compare the (guaranteed) mortality assumptions used in the contract to see how they might compare with other tables. I would suggest that the insurance illustration be generated at a more reasonable assumption--say 4%. That still gets huge deductions, not to mention commissions.

So if the abortion is going to happen anyway.....

[Belgarath]

Hi Merlin -

Well, starting first with the argument that you can fund a 412(i) plan with only life insurance. As far as I can tell, this relies on a very strict and narrow reading of the first sentence of 1.412(i)-1(b)(2)(i), placing form over substance.

I don't happen to agree. This sentence doesn't exist in a total vacuum, where 412(i) exists independently of the rest of the qualified plan world. The IRS has said essentially that incidental rules apply to all plans. There is nothing in the incidental limits rulings that exempts 412(i) plans. And while those promotors will give you their arguments as to why I'm wrong, I simply don't agree. And it appears that the IRS is on my side. P.S. - for some RR's, take a look at 61-121, 68-31, 68-453, 66-143, 70-611, and 74-307.

As far as the (a)(4) issues - as I've previously stated in other postings, I don't agree with Mr. Holland's interpretation. Of course, that doesn't mean I'm right, but I think the logic is rather flawed. As long as all the settlement rates are the same, etc., and as long as the same policies are purchased for all participants, it should meet the safe harbor definition. There's obviously a clear intent for a 412(i) plan, which by regulation may include both insurance and annuities, to have a safe harbor under the (a)(4) regs. But we'll see...

[Guest smhjr]

This is sort of a theoretical or academic follow up to Merlin's original question regarding 412(i) plans defining the accrued benefit to equal the CSV. His question was based on the first year having zero CSV, but I am wondering conceptually what would be done at NRA with the very large CSV.

Disregard any thoughts on insurance or fair market values. Just think of an annuity only plan and the cash build up from let's say age 35 to 60.

(1)If the insurance company needs $3,000,000 at age 60 based on its 2% guaranteed annuity in order to pay the individual $13,750 a month for the rest of his life and then the participant chooses a lump sum distribution at NRA what happens?

If the CSV=AB then his AB=$3,000,000. I would think that if a lump sum is chosen you can not rely on a 2% post retirment rate because the asset is no longer inside the plan that is allowed to assume 2%. (2)Wouldn't there be a potentially large discount on that lump sum figure? I'm pretty sure you can't get a lump sum of $3,000,000 from a DB plan. (3)Wouldn't you be back to requiring an actuary to figure out the distribution?

If the above is true then what about the mention in the regs from February of 412(i) plans funding for over the 415 limit. (4)Doesn't the plan have to fund to the $3,000,000 figure because the normal form of benefit is a life annuity?

Maybe the nature of 412(i) plans result in annuitizing the benefit as the only practical distribution option. I'm just wondering if anyone else has a take on it.

[Guest merlin]

Belgarath,

1. I've checked other sources, and they all agree that 100% life insurance is "verboten". 'Nuff said.

2. Any life insurance in any qualified plan, 412i or not, has to meet the incidental rules. Ditto.

3. The question of whether a 412i insurance/annuity combo could be a safe harbor was asked by an actuary in Indiana as part of a general information request. The the answer was that life insurance and annuity contracts are inherently not of the same series. Any difference in annuity purchase rates, or other features, would be considered a different benefit, right, or feature. "Sincerely, James E. Holland, Jr., Manager, Employee Plans Technical". Maybe that's the opening. If it's a BRF issue , and all the same policies are purchased for all participants, that s/b OK, right?

[Guest merlin]

smhjr,

Your last sentence says it all, I think. And how many of our typical (I'm assuming) small business/professioal clients want an annuity?

[mwyatt]

Hey Merlin:

My guess is nil, none, zilch, nada. Let's see: I supposedly have $3m that is going to pay me $170k a year, and if my wife and I decide to celebrate our new found fortune by taking a cruise on the Titanic, my reserve turns into gains for the insurance company?

This is the situation never answered by the agents: what happens at the end? The wink, wink is that no, you don't fund this thing for the full period, but only for the first five to seven years so you don't override the IRC 415 lump sum limit. Well, I'm not that old, but I do remember the TRA '86 transition that created overfunded plans that only got solved with improvements to the 415 limits and a general market meltdown (the only silver lining in the stock market crash). Last I checked, the EGTRRA 415 limits go poof 12/31/09 or 10, and you now have a firm interest rate cap of 5.5% for lump sums.

[Guest merlin]

Yup. And I have a very strong feeling that there are a lot of people out there pushing 412is who aren't knowledgeable enough to even get to the "wink,wink" stage.

[Belgarath]

I agree that there's no BRF issue, since all participants are issued the same policies. And if that was truly the thrust of Mr. Holland's opinion, I wouldn't find it troubling at all. But he says, "With regard to your particular questions regarding safe harbor plan designs, we note that you have presumed that it is possible for a section 412(i) plan that is funded through a combination of annuity contracts and life insurance contracts to satisfy the requirements of that section 1.401(a)(4)-3(b)(5)(vii) of the regulations. Such is not the case. Life insurance and annuity contracts are inherently not of the same series. Any difference in annuity purchase rates, or other features, would be considered a different benefit, right, or feature."

Now, I don't have copies of the two letters TO the IRS, so it may well be that this paragraph, in response to a specific request or situation, could easily be taken out of context. Again, I would argue that if policies were specifically designed to have the same annuity purchase (settlement) rates, etc., and if the same policies are purchased for all participants, that the safe harbor is satisfied.

But we'll see.

[AndyH]

mywatt's comments are as close to a 5 run home run as I've seen. Those points are going in my 412(i) file.

[Guest merlin]

That's only the 2nd 5-run homer I've ever heard of. David Ortiz hit the first one against the Yankees in the ALCS.

[mwyatt]

Actually, I'd put Damon's GS in the 2nd in the ultimate "how to creat a vacuum in the Bronx" category. The only excitement in game 7 from there on in was Petey in the 7th inning (I guess all of these Yankee fans can now venture to Shea to try out the "who's your daddy" chant).